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# Covered Interest Arbitrage

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7. Covered Interest Arbitrage (CIA)

7. Covered Interest Arbitrage (CIA)

Given the following:

US 90-day interest rate 5%
Current Spot Rate \$0.8512/C\$
90-day Forward Rate \$0.8501/C\$

You have \$1 Million and would like to engage in CIA:

i.) Outline the steps for CIA with the appropriate computation there of and compute the profit.

ii) Compute the Return on Investment of \$1 million and identify its components:

a) Interest Rate Component and
b) Exchange Gain/Loss Component

iii) For Interest Rate Parity to prevail, what should be the forward rate of the C\$?

#### Solution Preview

7. Covered Interest Arbitrage (CIA)

Given the following:

US 90-day interest rate 5%
Current Spot Rate \$0.8512/C\$
90-day Forward Rate \$0.8501/C\$

You have \$1 Million and would like to engage in CIA:

i.) Outline the steps for CIA with the appropriate computation there of and compute the profit.

ii) Compute the Return on Investment of \$1 million and identify its components:

a) Interest Rate Component and
b) Exchange Gain/Loss Component

iii) For Interest Rate Parity to prevail, what should be the forward rate of the C\$?

iii) For Interest Rate Parity to prevail, what should be the forward rate of the C\$?

For interest rate parity to prevail
Forward rate / Spot rate = (1+ US interest rate x 90/365) / (1+ Canadian interest rate x 90/365)

or Forward rate / \$ 0.8512 = (1+ 5% x 90/365) / (1+ 10% x 90/365)

or Forward rate = \$0.8410 /C\$

i.) Outline the steps ...

#### Solution Summary

Illustrates the mechanism of Covered Interest Arbitrage.

\$2.19